Three Examples Of Direct Indexing In Action
It’s been a great year. You hit it big…
You still can’t believe your college roommate, who used to sleep until noon, founded a company set to IPO. Looks like that $20,000 angel check you wrote him 15 years ago was worth it.
Now you’re left with hundreds of thousands of capital gains and you know the tax man is going to knock on your door. And no, Grandpa’s 95-year-old CPA can’t help you get out of this one.
What to do now? Cue Frec Direct Indexing. Direct indexing is an investment strategy that allows investors to accumulate capital losses while investing in a passive index like the S&P 500. It does so because investors own individual stocks in a specific index, rather than investing in a mutual fund or exchange-traded fund (ETF) that tracks the index. While the use cases are myriad, below we’ve highlighted some of the principal advantages.
Supercharged tax loss harvesting gets you more
Arguably the biggest benefit of direct indexing is the ability to harvest tax losses. You’ve heard the term before but you’ve always thought direct indexing was reserved for wealth managers. Maybe you didn’t even know it existed. Can a tax break really matter that much? I think you already know the answer.
Let’s say you moved your $500,000 portfolio over to Frec Direct Indexing a year ago and it has been harvesting daily losses. You now find that you’ve stumbled upon your dream house despite the suboptimal housing market and decide to make a down payment. So, you sell your shares of your friend’s now post-IPO company. You could save as much as $31,0901 on your capital gain taxes just by offsetting those gains on your tax bill.
Tax loss harvesting can help you reduce your overall tax bill, especially in years when you have realized significant capital gains. Some platforms offer ETF-to-ETF tax loss harvesting, but these are less savings as they’re not harvesting on the individual stock level. Better yet, you carry your tax losses forward if you don’t use them in a particular year.
Personalization lets you make the index your own
Let’s say you work at one of those cushy tech jobs like Apple. Your pay package includes a sizable equity plan and you’ve quietly drummed up quite a position. Meanwhile, you want to diversify your portfolio by investing in the S&P 500. You realize that Apple makes up 6.90%2 of the S&P and think the only option is to invest in an ETF tracking the index – meaning, you would be forced to buy even more Apple stock. The opposite of what you wanted.
Not anymore. With direct indexing, you can customize your S&P portfolio by simply excluding Apple, enjoying a level of personalization and customization not available in traditional index or ETF investing. You could even go as far as creating your own index.
Easy transfers avoid selling your stocks
You work in Silicon Valley and you have been bullish on tech so a large portion of your $1 million portfolio is in early positions you took on Apple and Nvidia. After a strong 5 years for both, you find yourself well overexposed. And sure you think they may continue to go up, but you’re not counting on it. You wanted a diversified portfolio, not a portfolio comprised mostly of two stocks. With Frec Direct Indexing, you don’t have to sell each stock and rebuy it, incurring significant capital gain taxes. Instead, you can simply transfer the target allocations of Apple and Nvidia, in stock, potentially saving yourself thousands in dollars in taxes.
“Nothing is certain except death and taxes.” Many of us are brutally reminded of Benjamin Franklin’s famous quote every April 15th. With Frec Direct Indexing, you optimize for both returns and tax savings. Because at the end of the day, it’s not how much you earn that matters – but how much you keep.
- This is based on a projected tax loss harvesting of 14.7% in the first year with a tax rate applied of 42.3%. The 14.7% was generated by Frec’s Direct Indexing Model tracking the S&P 500 index and is hypothetical, does not reflect actual investment results, and is not a guarantee of future results. Simulations were run on a weekly basis in a ten-year time frame from December 7, 2003 through June 10, 2022 with a $50,000 initial deposit. Results may vary.
- As of 09/19/2023.